Paying your taxes isn’t something that is optional, but one area where you do have a choice is how you decide to approach your tax deductions. After determining your total income, adding up all the sources of income and subtracting any adjustments to income, you will need to decide which deduction option to choose.
Adjustments to Income and Standard or Itemized Deductions
Each taxpayer has two options: the standard, federally defined deduction or itemizing your deductions. The method that you choose can make a big difference on your tax return. While most taxpayers would agree that it is easier to take the standard deduction, it is in your best interest to take whichever deduction is larger. Don’t be tempted to accept the standard deduction without doing your research. Take time and explore the potential benefit of itemizing your deductions to make sure you are making the best tax choice.
The Standard Deduction is Growing
The standard deduction is commonly thought of as the easy way out. It’s so easy that about 2/3rds of taxpayers take this option and move on with their day. Now that standard deductions are nearly doubling under the new tax law, it’s expected that even more taxpayers will take the standard deduction.
The biggest benefit to choosing the standard deduction is that it’s convenient and saves time. Selecting the standard deduction, based on your taxable income, doesn’t require taxpayers to fill out additional forms, like a Schedule A, or devote the time to claim each and every deduction.
Some taxpayers might qualify for a bigger deduction when they choose the standard deduction. Depending on age, disability, or filing status, some individuals might be eligible for a bigger standard deduction. The standard deduction makes exceptions that itemized deductions don’t. For example, you’ll be allowed to take a standard tax deduction even if you don’t have expenses that qualify you to make itemized deductions.
It’s also important to note that some people don’t qualify for the standard deduction and therefore should itemize. This list includes married couples who file separate returns and one spouse itemizes. Although not as common, if you’re a nonresident alien, a dual-status alien or someone who is filing a tax return for a period of less than a year, then you won’t be eligible for the standard deduction. Additionally, if you’ve been claimed as a dependent on someone else’s taxes your deduction might be limited.
Getting the Most From Itemized Deductions
With the loss of personal exemptions, the higher standard deduction might not be as rosy as it appeared. For a married couple, filing jointly, with two kids, you previously got a $12,700 standard deduction plus $16,200 in exemptions, which totaled $28,900 in tax-free income. While the new $24,000 standard deduction sounded good up front, you’re now several thousand dollars behind where you were.
If your total itemized deductions are greater than the standard deduction, you could benefit from itemizing. However, it’s important to be aware of changes that are coming to itemized deductions in 2018 covering:
- Medical and dental expenses
- State and local taxes
- Foreign taxes
- Casualty and theft losses
- Charitable gifts
On your 2017 taxes, medical and dental expenses were only deductible if they topped 10% of your adjusted gross income. The news gets better for 2018, as that threshold is lowered to 7.5%. But, as a business owner, if you truly want to maximize your medical deductions, it’s possible that a medical expense reimbursement plan may let you deduct 100% of your family’s medical bills as a business expense.
The new tax law caps state and local taxes at $10,000, regardless of how much you actually pay. It’s possible that limiting this deduction will impact how some states raise revenue. Some states have discussed switching to employer-side payroll taxes or business franchise taxes. This change, coupled with the change to mortgage interest, is likely to be felt the hardest in urban coastal areas.
Just like medical and dental expenses, it will be important to realize strategic opportunities within the new rules for itemized deductions. While the new tax law eliminates the “freebie” deduction for interest on home equity up to $100,00, home equity interest on an unlimited amount of debt is still deductible if you use the proceeds for a deductible purpose. Which means if you borrow against your house to finance your business, you can still write it off as business interest.
One positive change to itemized deductions is getting rid of “Pease limits” that used to phase out itemized deductions if your income passed certain thresholds. Now, if you choose to itemize, you will get to use all of the deductions.
Tax deductions reduce your taxable income, which makes choosing the best deduction an important decision. Financial Gravity wants to make sure you don’t overpay when it comes to your taxes. Understanding how our tax system really works, including standard and itemized deductions, will allow you to choose the higher deduction, and pay the lower amount of tax. Ready to dive deeper into the new tax rules and learn strategies for paying less taxes? Download your free copy of The New Tax Law book!